Why LBO gives the lowest valuation

The lower valuations in LBOs stem from three structural factors:

• IRR hurdle rate requirements — fund return targets mathematically cap the entry price. You can’t overpay

• Leverage constraint — debt service capacity limits restrict how much of the purchase price can be debt financed

• Zero synergies and standalone basis — PEs price only the business as it is today, not the version it could become inside a larger group

IRR requirements mathematically cap the entry price

Private equity funds are built around hard return thresholds that dictate how much they can pay. A typical mid-market buyout fund targets around a 20% gross IRR and a 2,5x–3,0x money-on-money return over a five-year hold period. Since IRR depends on the relationship between entry price, exit price, and holding period, it becomes mathematically impossible to overpay and still reach the required return. The higher the entry valuation, the smaller the gain after debt service and conservative EBITDA development — IRR is hypersensitive to entry price.

Because of this, every LBO model works backward from the target return. The fund assumes a reasonable exit multiple, builds a conservative business plan, and discounts back to the maximum price it can afford to pay today while still meeting its IRR hurdle. That figure becomes the entry-price ceiling — determined not by sentiment or market comparables, but by the discipline of the model itself. Even outstanding businesses remain constrained by fund economics rather than strategic optimism.

In practice, this creates a consistent valuation gap: if trading comps imply EUR 100m, private equity bidders might land around EUR 70m–90m, while a strategic buyer — factoring in synergies or market share — could justify paying EUR 110m to secure exclusivity.

Leverage capacity limits how much PE can pay

Most of the return in an LBO comes from debt paydown and leverage, not from multiple expansion or too aggressive growth. This makes the maximum leverage capacity the one of the valuation limiters. A company that can sustain 4,0x leverage supports a higher purchase price than one capped at 2,5x, but that capacity depends on the stability and predictability of cash flows, not investor enthusiasm.

The relationship is straightforward: Leverage ↑ → Returns ↑ → Room for error ↓. Higher leverage amplifies equity returns in the base case but also magnifies downside risk, as debt service consumes most of the free cash flow. The margin for error tightens — the business plan must deliver, and missing EBITDA projections quickly erodes equity value.

In practice, this discipline limits entry valuations. PE buyers prefer to make small discounts to the forecasted EBITDA and preserve headroom rather than stretch for aggressive growth assumptions and risk breaching covenants. The result is a lower entry price that allows enough headroom for leverage.

Zero synergies compress the PE valuation relative to strategics

Private equity funds base their valuation on the standalone performance of the target. They will not price in synergies, operational overlaps, or strategic cross-sell opportunities that have yet to materialize. By contrast, strategic buyers can justify paying more because they can integrate the target into an existing platform, realize cost synergies, or accelerate revenue growth through distribution or product leverage.

This creates a systematic valuation gap. While a PE buyer prices the business on its own, a strategic buyer prices it as part of a larger ecosystem. PEs buy the company that exists today and usually already in good shape; strategics pay for the company they can create tomorrow.

Where does it leave us?

LBO valuations are the lowest because private equity funds must hit their IRR requirements. They can’t afford to overpay — every extra turn of EBITDA paid at entry eats into their IRR at exit. Unlike strategic investors, which can justify higher prices with synergies or long-term integration benefits, PE buyers are financial investors whose model depends on buying well, leveraging prudently, and exiting within a fixed time frame.